Tuesday, January 19, 2010

More on risk and investing

Earlier, I wrote:
So why is it that I see so much push towards increasing payoffs to investment, but relatively little on enhancing the safety nets for failed outcomes?  I mean, it's understandable to think about the successes, but we can't ignore the "risk" in "risk-taking".  If we truly want to encourage people to take more risks, with the belief that risk-taking promotes economic growth, shouldn't we be using a full mix of incentives?  In other words, why so much "Incentive A" from above, but so little "Incentives B & C"?  Especially since, in my personal view, the likelihood that my future huge estate will be taxed upon my death is an infinitely minor reason for me not to strike out on my own. 
I recently saw an interesting post by James Kwak on this issue. He writes about how his experience contrasts with the conventional wisdom that "successful entrepreneurs get that way by taking big risks".  The punchline (for me) is here:
The best encouragements to productive risk-taking are measures that limit the cost of failure for people who are actually creating something new, and this is one reason why Silicon Valley has been so successful. The financial risks of starting a company aren’t that big, for most people. High-tech companies are typically started by people who could pull in low-six-figure salaries working for other companies, so they’re giving up a couple of hundred thousand dollars in opportunity cost; the rest is typically angel investor or venture capital money. More importantly, there is (historically, at least), little stigma attached to failure, so there’s little reputational downside to a failed startup. In a world full of risk-averse people, that’s very important.
Obviously, I agree.  I think we should be concerned about how to motivate product investment, but I currently believe that taxation policies (particular estate tax issues) are secondary to other (dis)incentives.**  So, again, my punchline is that the idea of a safety net is important.

**I'm speaking in terms of individuals deciding whether to start a business, not on corporations deciding whether to make incremental investments.  I think it's clear that taxation is a first-order effect on the large corporate level.  My thoughts are focused on what motivates individual and small business investing decisions because I keep hearing how those are the engines of the economy that will drive us out of the recession (although, technically, the recession is over I guess).  

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